Level 100 Level 102
Level 101

Hedging Interest Rate Risk

51 words 0 ignored

Ready to learn       Ready to review

Ignore words

Check the boxes below to ignore/unignore words, then click save at the bottom. Ignored words will never appear in any learning session.

All None

takes a position for a short time to capitalize on short term price movements
position trader
speculator holds a position for a longer period trying to profit from price movements in the long term
wants to reduce risk
grains, fruits, livestock, metals, securities
what commodities trade on the futures market?
Micro vs Macro Hedgin
micro - particular asset or liability
basis risk
difference in prices between the cash market and the futures market (now vs delivery)
correlation risk
risk that price decreases in the hedged item will not be offset by the futures contract
Credit risk
possibility that borrower will not meet the scheduled repayments and default on their loan
marking to market risk -
risk that you or firm will be unable to cover a margin call
managerial risk
risk that management may not understand the futures contract or over/under hedge
long buy
Micro - bank has assets maturing in 3 months, funded using 6 month CDs
Micro - bank wishes to hedge against risk that mortgages will be refinanced
long buy - people refinance when rates go down, bank take position that profits when rates go down
hedge short
Macro - bank has POSITIVE DGAP its balance sheet is hedged by
hedge long
if bank has a NEGATIVE DGAP
why do swaps exist
as hedging tool to offset volatile interest rates
define $GAP
measure of expected changes in MV of assets and liabilities
define DGAP
approximate % change in market value of a fixed cash flow for given IR change
Cost of insurance which can be payed as a lump sum or through installment for the duration of the policy
duration = maturity
what is the duration of a zero coupon bond
Duration GAP
Always uses market value figures
Dollar GAP
Always uses book value figures
short funded
are most banks short funded or long funded?
would a short funded institution have a positive or negative $gap.. what about DGAP?
negative - short funded tend to have a lot of rate sensitive liabilities and
discount = longest
what maturity has the longest duration... shortest duration?
alter security portfolio
how can we alter a banks DGAP
Define - Immunized portfolio
MV of equity is unaffected by irate changes
define credit derivative
contracts that allow users to mange their exposure to credit risk (forwards, swaps, options)
credit default swaps
two parties enter agreement where one party pays insurance coupons for life of agreement, the other party makes no payments unless specified credit event occurs
total return swap
parties swap periodic payment over the life of agreement. one party makes payments based on total return - the other makes fixed payments with vanilla IR swap
credit linked note
debt instrument bundled with embedded credit derivative
Asymmetric Information
situation when one party doesn't know enough about the other party to make accurate decisions. This creates two kinds of problems:
moral hazard
the risk that one party to a transaction will engage in behavior that is undesirable from the other party's point of view
long term projects
2 types of commercial loans
Portfolio Credit Factors
correlation of Default risks for loan projects
real estate loans
largest component of a banks loan portfolio
why are small banks focusing on lending to less transparent firms
large banks are getting the easy loans, leaving the less traditional loans for the smaller banks
examples of forbearance
extending maturity of loan
benefits to bank borrowing vs direct finance
banks more willing to forbear than bondholders
Credit analysis basics (loan officer)
what risks are inherent in operations of the firm?
position limits
maximum allowable credit exposure of any single borrower, industry, or location (one single loan so large if it defaulted bank would be in financial distress)
risk rating loans
grade loans on likelihood of default and amount of loss (loans may have high default rate, but loss due to default may be acceptable)
loan covenants
rules for borrower during life of the loan (no mergers, changes in capital structure, extreme decisions)
credit review
annually monitoring performance of borrowers and handling problem loans
Methods bank uses to generate loans (6)
is it better to lend too much or too little?
both undesirable - borrower should know exactly how much they need, or they will waste it
when collateral is highly liquid and exceeds loan amount
when is it important to determine source and timing of repayment
anything legal
what can serve as collateral
should collateral value be less than, equal to, or exceed the loan value
can be any, but greater than is in the best interest of the bank
double leveraged firms
When a bank holding company conducts a debt offering to acquire a large equity stake in a subsidiary bank
Times interest Earned ratio
measures a banks ability to pay its interest incurred obligations
characteristics of bad loan requests
complaceny (ok in future is ok in past)